Zombie Policy Apocalypse: A Look at Insurance in Superannuation

Insurance within Superannuation accounts makes up almost half of the insurance market.

Approximately 12 million Australian’s hold some type of insurance via their superannuation account. With the issue of insurance in superannuation impacting the lives – and livelihoods – of so many Australians, the Productivity Commission has taken a much closer look. From zombie policies to member disengagement, we examine the key call-outs from the Productivity Commission on whether insurance in superannuation provides value for money to members.

The Argument for Insurance in Super:

Despite being on the receiving end of a lot of criticism, insurance provided through superannuation still delivers an affordable insurance option to most Australians. The Commission found there to be many reasons to support insurance in super, including:

Group Insurance Policies – Super uses a pooling mechanism to provide insurance policies to an entire group of people, called group insurance. Group Insurance policies can be provided at a cheaper rate than individually underwritten policies because it pools risk and reduces adverse selection. This means that an individual with higher risk factors can access insurance at a significantly cheaper rate than under an individually written policy.

Opt-Out Arrangements – Super’s default opt out arrangement helps to address the reported problems of under-insurance. It provides a safety net to members who may have otherwise chosen not to take out life insurance – or were unable to. It can also financially benefit members who may not understand the importance of insurance.

Financial Benefits – There are financial benefits to members paying for their insurance through super; members can pay using money that they cannot currently spend – and it is taxed concessionally.

What is Reducing the Value of Insurance in Superannuation?

Over a third of all member complaints against super funds were in relation to insurance. While there are both efficiency and member well-being benefits, the Commission identified a range of potential issues that reduced the value of insurance.

1. Member disengagement and lack of awareness.

The Commissions’ Survey found members were relatively disengaged, which made it difficult to a draw conclusion about their perceptions of value.

Most members had some awareness that insurance was bundled into their super account, but 24% had no idea. 16% indicated they knew they were paying for insurance but didn’t know what it was. Only 12% of members responded they knew a lot about insurance.

The survey showed that very few members amend or opt out of the default insurance cover. 78% of members reported never making changes to their default cover and only 6% had opted out in the past 12 months. The two most common reported reasons for not opting out were lack of knowledge (35%), and assuming the cover was appropriate (35%).

2. Inappropriate cross-subsidisation.

Cross subsidisation is the act of charging higher prices to one group of consumers to subsidise lower prices in another group. By averaging risks across a population of people, superannuation funds can offer group insurance at a relatively cheap rate.

But is appropriate cross subsidisation occurring?

For insurance to be of value, premiums need to accurately reflect the risk of the member. Some clear examples of risk factors that should affect a member’s premium include their age, smoking status, and occupation i.e. white vs blue-collar work. Unfortunately, ASIC recently noted that in some cases trustees had transferred members to different divisions of the fund and classified them by default as a smoker or blue-collar worker for insurance purposes. This resulted in higher premiums that may not reflect the risk factors of the member at all.

3. Low value policies.

The nature of group insurance means products can’t be tailored to individual needs. By providing insurance at a level that prevents excessive balance erosion for low income members, higher income members may find their automatic level of cover fails to meet their needs and preferences.

It could be said that poor tailoring of insurance can result in insurance that is low value and or causes excessive balance erosion for some cohorts of members. Funds need to use the information they collect from members to develop insurance cover that limits this undesirable outcome and better meets member needs.

4. Difficulty engaging with super funds on insurance.

Around 80% reported that modifying or taking out new insurance cover was somewhat easy, but nearly half had trouble when trying to opt out. This contracts with funds reports that their members were the most satisfied with the opt out process.

Unfortunately there weren’t enough responses collected to provide a thorough assessment of the insurance claims process, but some of the ASIC complaint findings indicated:

The claims process involved raising awareness of insurance cover

The process is complex and time consuming, and

A substantial share of disputes were related back to the insurance claims process

5. Account proliferation.

It was estimated that 17% of members were holding two or more accounts with insurance in 2017. The premiums collected from these unintended duplicate insurance policies would amount to approximately $1.9 billion per year. Most of these additional accounts are likely to be inactive. It was estimated that there are approximately 3 million inactive accounts that also had insurance cover.

These additional accounts are costing Australian’s thousands over their lifetimes. It was estimated that a member with two super accounts from the age of 25 – 45 would be $55,000 worse off by the time they reach retirement than a member with only one account.

Balance erosion is especially bad for members with multiple accounts. These members may end up over-insured or find themselves unable to claim on the multiple accounts. These are also known as ‘zombie policies’.

So… Is Insurance Value for Money to Members?

For some members the default insurance in terms of premiums paid insurance in super is undeniably good value, and it can provide access to insurance for some people who might not be able to get individually underwritten insurance. However, better tailoring of group insurance to different member cohorts would improve the value of insurance to many members.

Unfortunately, there are many circumstances where insurance doesn’t provide value to members and can be detrimental toward their super balance – for example, younger workers with no dependants will get less value from life insurance, and low income earners will get less value from income protection insurance. For many, insurance provides poor value and does not meet their needs simply because they are uninformed and disengaged and do not elect to opt out as a result.